Kansas Adopts Controversial Tax Legislation

A bill recently passed by the Kansas legislature, and signed into law by Governor Sam Brownback in May, makes significant changes to Kansas income tax laws. The new law significantly reduces personal income taxes, eliminates income taxes for many small businesses and trims about a half-cent off the state sales tax.

The law includes the following changes and reductions in Kansas taxes:

Income Tax Rates

The current three-bracket income tax rates for individual taxpayers (3.5 percent, 6.25 percent, and 6.45 percent) are changed to a two-bracket system with lower rates of 3.0 percent and 4.9 percent beginning in 2013. This has been described as a 24% reduction in income tax rates for individuals by supporters of the law.

For married individuals, the 3 percent rate applies to taxable income up to $30,000 and the 4.9 percent rate applies to all amounts over $30,000.

For single individuals, the 3 percent rate applies to taxable income up to $15,000 and the 4.9 percent rate applies to all amounts over $15,000.

No Tax on Small Business Income

Another very significant change for individual taxpayers is the total elimination or exemption from income taxes for certain non-wage business income for small business owners. The law provides that income reported to individual owners by limited liability companies, Subchapter S corporations, partnerships, and sole proprietorships, including farm income, are excluded from income tax beginning in 2013. This exclusion from income is available only to individual taxpayers and applies to non-wage business income reported on federal Form 1040 Schedules C, E and F. Thus, it applies to ordinary business income and net income from rental real estate, but not capital gains generated from business or real estate operations.

What This Means for Kansas Taxpayers

The practical impact of this change in Kansas individual income taxes beginning in 2013 is illustrated by the following three scenarios:

An individual Kansas resident taxpayer with Kansas source income (i.e. business income derived from operations in Kansas) will receive the most benefit under the new legislation. If the resident taxpayer had the types of exempt non-wage business income described above, there will be no tax in Kansas on that income.

An individual Kansas resident taxpayer with income sourced to another state may still receive a benefit under the new legislation if the income tax rate in the sourced state is lower than the new income tax rate in Kansas. If the resident had the types of exempt non-wage business income described above, there may be tax on such income in the source state, but that income will not be taxed in Kansas.

An individual non-Kansas resident taxpayer with income sourced to Kansas will receive a benefit under the new legislation as long as the taxpayer's resident state income tax rate is lower than the new income tax rate in Kansas. If said non-resident had the types of exempt non-wage business income described above, there will be no tax on that income in Kansas, but that income may be taxed in the taxpayer's resident state.

As a result of these new benefits to taxpayers who are Kansas residents and non residents, it is likely that some taxpayers will restructure their business operations to derive a greater percentage of their income from Kansas sources.

A close reading of the new law indicates that C corporations (regular business corporations that are not treated as S corporations) cannot get the benefit of the tax exemption described above, since they are not treated as individuals. The new law does include farm income in the special treatment exempting certain income from Kansas income taxes, although this part of the law has received little publicity and needs additional explanation from the state (e.g. a definition of farm income).

In order to provide some relief to the state, and limit the benefit of the tax rate reductions and tax exemptions noted above, the law provides that losses from the small businesses described above are not allowed to reduce Kansas taxable income beginning in 2013. The law is not clear how these disallowed losses are to be handled by Kansas taxpayers, and this is one of several questions that will need to be addressed by the Department of Revenue when it issues rules and regulations. In addition, the law also provides that certain income tax credits and deductions will no longer be allowed to individuals, including food sales tax rebates, adoption expenses, child and dependent care expenses, child day care expenses, and various other credits. Some of these tax credits and deductions will still be available to corporate taxpayers.

The law also increases the standard deduction used by individual taxpayers who are married filing jointly or head of household to $9,000 in 2013.

In addition, the bill preserves a section in the current tax law that reduces the state sales tax rate from 6.3 percent to 5.7 percent which becomes effective on July 1, 2013. Previous versions of the act had proposed to eliminate that reduction.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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